Shale, the Last Oil and Gas Train: Interview with Arthur Berman

How much faith can we put in our ability to decipher all the numbers out there
telling us the US is closing in on its cornering of the global oil market?
There's another side to the story of the relentless US shale boom, one that
says that some of the numbers are misunderstood, while others are simply preposterous.
The truth of the matter is that the industry has to make such a big deal out
of shale because it's all that's left. There are some good things happening
behind the fairy tale numbers, though--it's just a matter of deciphering them
from a sober perspective.

In a second exclusive interview with James Stafford of Oilprice.com,
energy expert Arthur Berman discusses:

Why US gas supply growth rests solely on Marcellus

When Bakken and Eagle Ford will peak

The eyebrow-raising predictions for the Permian Basin

Why outrageous claims should have oil lawyers running for cover

Why everyone's making such a big deal about shale

The only way to make the shale gas boom sustainable

Why some analysts need their math examined

Why it's not just about how much gas we produce

Why investors are starting to ask questions

Why new industries, not technologies will make the next boom

Why we'll never hit the oil and gas 'wall'

Why companies could use a little supply-and-demand discipline

Why 'fire ice' makes sense (in Japan)

Why the US crude export debate will be 'silly'

Arthur is a geological consultant with thirty-four years of experience in
petroleum exploration and production. He is currently consulting for several
E&P companies and capital groups in the energy sector. He frequently gives
keynote addresses for investment conferences and is interviewed about energy
topics on television, radio, and national print and web publications including
CNBC, CNN, Platt's Energy Week, BNN, Bloomberg, Platt's, Financial Times, and
New York Times. You can find out more about Arthur by visiting his website: http://petroleumtruthreport.blogspot.com

Oilprice.com: Almost on a daily basis we have figures thrown at us
to demonstrate how the shale boom is only getting started. Mostly recently,
there are statements to the effect that Texas shale formations will produce
up to one-third of the global oil supply over the next 10 years. Is there another
story behind these figures?

Arthur Berman: First, we have to distinguish between shale gas and
liquids plays. On the gas side, all shale gas plays except the Marcellus are
in decline or flat. The growth of US supply rests solely on the Marcellus and
it is unlikely that its growth can continue at present rates. On the oil side,
the Bakken has a considerable commercial area that is perhaps only one-third
developed so we see Bakken production continuing for several years before peaking.
The Eagle Ford also has significant commercial area but is showing signs that
production may be flattening. Nevertheless, we see 5 or so more years of continuing
Eagle Ford production activity before peaking. The EIA has is about right for
the liquids plays--slower increases until later in the decade, and then decline.

The idea that Texas shales will produce one-third of global oil supply is
preposterous. The Eagle Ford and the Bakken comprise 80% of all the US liquids
growth. The Permian basin has notable oil reserves left but mostly from very
small accumulations and low-rate wells. EOG CEO Bill Thomas said the same thing
about 10 days ago on EOG's earnings call. There have been some truly outrageous
claims made by some executives about the Permian basin in recent months that
I suspect have their general counsels looking for a defibrillator.

Recently, the CEO of a major oil company told The Houston Chronicle that the
shale revolution is only in the "first inning of a nine-inning game". I guess
he must have lost track of the score while waiting in line for hot dogs because
production growth in U.S. shale gas plays excluding the Marcellus is approaching
zero; growth in the Bakken and Eagle Ford has fallen from 33% in mid-2011 to
7% in late 2013.

Oil companies have to make a big deal about shale plays because that is all
that is left in the world. Let's face it: these are truly awful reservoir rocks
and that is why we waited until all more attractive opportunities were exhausted
before developing them. It is completely unreasonable to expect better performance
from bad reservoirs than from better reservoirs.

The majors have shown that they cannot replace reserves. They talk about return
on capital employed (ROCE) these days instead of reserve replacement and production
growth because there is nothing to talk about there. Shale plays are part of
the ROCE story--shale wells can be drilled and brought on production fairly
quickly and this masks or smoothes out the non-productive capital languishing
in big projects around the world like Kashagan and Gorgon, which are going
sideways whilst eating up billions of dollars.

None of this is meant to be negative. I'm all for shale plays but let's be
honest about things, after all! Production from shale is not a revolution;
it's a retirement party.

OP: Is the shale "boom" sustainable?

Arthur Berman: The shale gas boom is not sustainable except at higher
gas prices in the US. There is lots of gas--just not that much that is commercial
at current prices. Analysts that say there are trillions of cubic feet of commercial
gas at $4 need their cost assumptions audited. If they are not counting overhead
(G&A) and many operating costs, then of course things look good. If Walmart
were evaluated solely on the difference between wholesale and retail prices,
they would look fantastic. But they need stores, employees, gas and electricity,
advertising and distribution. So do gas producers. I don't know where these
guys get their reserves either, but that needs to be audited as well.

There was a report recently that said large areas of the Barnett Shale are
commercial at $4 gas prices and that the play will continue to produce lots
of gas for decades. Some people get so intrigued with how much gas has been
produced and could be in the future, that they don't seem to understand that
this is a business. A business must be commercial to be successful over the
long term, although many public companies in the US seem to challenge that
concept.

Investors have tolerated a lot of cheerleading about shale gas over the years,
but I don't think this is going to last. Investors are starting to ask questions,
such as: Where are the earnings and the free cash flow. Shale companies are
spending a lot more than they are earning, and that has not changed. They are
claiming all sorts of efficiency gains on the drilling side that has distracted
inquiring investors for awhile. I was looking through some investor presentations
from 2007 and 2008 and the same companies were making the same efficiency claims
then as they are now. The problem is that these impressive gains never show
up in the balance sheets, so I guess they must not be very important after
all.

The reason that the shale gas boom is not sustainable at current prices is
that shale gas is not the whole story. Conventional gas accounts for almost
60% of US gas and it is declining at about 20% per year and no one is drilling
more wells in these plays. The unconventional gas plays decline at more than
30% each year. Taken together, the US needs to replace 19 billion cubic feet
per day each year to maintain production at flat levels. That's almost four
Barnett shale plays at full production each year! So you can see how hard it
will be to sustain gas production. Then there are all the efforts to use it
up faster--natural gas vehicles, exports to Mexico, LNG exports, closing coal
and nuclear plants--so it only gets harder.

This winter, things have begun to unravel. Comparative gas storage inventories
are near their 2003 low. Sure, weather is the main factor but that's always
the case. The simple truth is that supply has not been able to adequately meet
winter demand this year, period. Say what you will about why but it's a fact
that is inconsistent with the fairy tales we continue to hear about cheap,
abundant gas forever.

I sat across the table from industry experts just a year ago or so who were
adamant that natural gas prices would never get above $4 again. Prices have
been above $4 for almost three months. Maybe "never" has a different meaning
for those people that doesn't include when they are wrong.

OP: Do you foresee any new technology on the shelf in the next 10-20
years that would shape another boom, whether it be fossil fuels or renewables?

Arthur Berman: I get asked about new technology that could make things
different all the time. I'm a technology enthusiast but I see the big breakthroughs
in new industries, not old extractive businesses like oil and gas. Technology
has made many things possible in my lifetime including shale and deep-water
production, but it hasn't made these things cheaper.

That's my whole point about shale plays--they're expensive and need high oil
and gas prices to work. We've got the high prices for oil and the oil plays
are fine; we don't have high prices for the gas plays and they aren't working.
There are some areas of the Marcellus that actually work at $4 gas price and
that's great, but it really takes $6 gas prices before things open up even
there.

OP: In Europe, where do you see the most potential for shale gas exploitation,
with Ukraine engulfed in political chaos, companies withdrawing from Poland,
and a flurry of shale activity in the UK?

Arthur Berman: Shale plays will eventually spread to Europe but it
will take a longer time than it did in North America. The biggest reason is
the lack of private mineral ownership in most of Europe so there is no incentive
for local people to get on board. In fact, there are only the negative factors
of industrial development for them to look forward to with no pay check. It's
also a lot more expensive to drill and produce gas in Europe.

There are a few promising shale plays on the international horizon: the Bazherov
in Russia, the Vaca Muerte in Argentina and the Duvernay in Canada look best
to me because they are liquid-prone and in countries where acceptable fiscal
terms and necessary infrastructure are feasible. At the same time, we have
learned that not all plays work even though they look good on paper, and that
the potentially commercial areas are always quite small compared to the total
resource. Also, we know that these plays do not last forever and that once
the drilling treadmill starts, it never ends. Because of high decline rates,
new wells must constantly be drilled to maintain production. Shale plays will
last years, not decades.

Recent developments in Poland demonstrate some of the problems with international
shale plays. Everyone got excited a few years ago because resource estimates
were enormous. Later, these estimates were cut but many companies moved forward
and wells have been drilled. Most international companies have abandoned the
project including ExxonMobil, ENI, Marathon and Talisman. Some players exited
because they don't think that the geology is right but the government has created
many regulatory obstacles that have caused a lack of confidence in the fiscal
environment in Poland.

The UK could really use the gas from the Bowland Shale and, while it's not
a huge play, there is enough there to make a difference. I expect there will
be plenty of opposition because people in the UK are very sensitive about the
environment and there is just no way to hide the fact that shale development
has a big footprint despite pad drilling and industry efforts to make it less
invasive.

Let me say a few things about resource estimates while we are on the subject.
The public and politicians do not understand the difference between resources
and reserves. The only think that they have in common is that they both begin
with "res." Reserves are a tiny subset of resources that can be produced commercially.
Both are always wrong but resource estimates can be hugely misleading because
they are guesses and have nothing to do with economics.

Someone recently sent me a new report by the CSIS that said U.S. shale gas
resource estimates are too conservative and are much larger than previously
believed. I wrote him back that I think that resource estimates for U.S. shale
gas plays are irrelevant because now we have robust production data to work
with. Most of those enormous resources are in plays that we already know are
not going to be economic. Resource estimates have become part of the shale
gas cheerleading squad's standard tricks to drum up enthusiasm for plays that
clearly don't work except at higher gas prices. It's really unfortunate when
supposedly objective policy organizations and research groups get in on the
hype in order to attract funding for their work.

OP: The ban on most US crude exports in place since the Arab oil embargo
of 1973 is now being challenged by lobbyists, with media opining that this
could be the biggest energy debate of the year in the US. How do you foresee
this debate shaping up by the end of this year?

Arthur Berman: The debate over oil and gas exports will be silly.

I do not favor regulation of either oil or gas exports from the US. On the
other hand, I think that a little discipline by the E&P companies might
be in order so they don't have to beg the American people to bail them out
of the over-production mess that they have created knowingly for themselves.
Any business that over-produces whatever it makes has to live with lower prices.
Why should oil and gas producers get a pass from the free-market laws of supply
and demand?

I expect that by the time all the construction is completed to allow gas export,
the domestic price will be high enough not to bother. It amazes me that the
geniuses behind gas export assume that the business conditions that resulted
in a price benefit overseas will remain static until they finish building export
facilities, and that the competition will simply stand by when the awesome
Americans bring gas to their markets. Just last week, Ken Medlock described
how some schemes to send gas to Asia may find that there will be a lot of price
competition in the future because a lot of gas has been discovered elsewhere
in the world.

The US acts like we are some kind of natural gas superstar because of shale
gas. Has anyone looked at how the US stacks up next to Russia, Iran and Qatar
for natural gas reserves?

Whatever outcome results from the debate over petroleum exports, it will result
in higher prices for American consumers. There are experts who argue that it
won't increase prices much and that the economic benefits will outweigh higher
costs. That may be but I doubt that anyone knows for sure. Everyone agrees
that oil and gas will cost more if we allow exports.

OP: Is the US indeed close to hitting the "crude wall"--the point at
which production could slow due to infrastructure and regulatory restraints?

Arthur Berman: No matter how much or little regulation there is, people
will always argue that it is still either too much or too little. We have one
of the most unfriendly administrations toward oil and gas ever and yet production
has boomed. I already said that I oppose most regulation so you know where
I stand. That said, once a bureaucracy is started, it seldom gets smaller or
weaker. I don't see any walls out there, just uncomfortable price increases
because of unnecessary regulations.

We use and need too much oil and gas to hit a wall. I see most of the focus
on health care regulation for now. If there is no success at modifying the
most objectionable parts of the Affordable Care Act, I don't suppose there
is much hope for fewer oil and gas regulations. The petroleum business isn't
exactly the darling of the people.

OP: What is the realistic future of methane hydrates, or "fire ice",
particularly with regard to Japanese efforts at extraction?

Arthur Berman: Japan is desperate for energy especially since they
cut back their nuclear program so maybe hydrates make some sense at least as
a science project for them. Their pilot is in thousands of feet of water about
30 miles offshore so it's going to be very expensive no matter how successful
it is.

OP: Globally, where should we look for the next potential "shale boom" from
a geological perspective as well as a commercial viability perspective?

Arthur Berman: Not all shale is equal or appropriate for oil and gas
development. Once we remove all the shale that is not at or somewhat above
peak oil generation today, most of it goes away. Some shale plays that meet
these and other criteria didn't work so we have a lot to learn. But shale development
is both inevitable and necessary. It will take a longer time than many believe
outside of North America.

OP: We've spoken about Japan's nuclear energy crossroads before, and
now we see that issue climaxing, with the country's nuclear future taking center-stage
in an election period. Do you still believe it is too early for Japan to pull
the plug on nuclear energy entirely?

Arthur Berman: Japan and Germany have made certain decisions about
nuclear energy that I find remarkable but I don't live there and, obviously,
don't think like them.

More generally, environmental enthusiasts simply don't see the obstacles to
short-term conversion of a fossil fuel economy to one based on renewable energy.
I don't see that there is a rational basis for dialogue in this arena. I'm
all in favor of renewable energy but I don't see going from a few percent of
our primary energy consumption to even 20% in less than a few decades no matter
how much we may want to.

OP: What have we learned over the past year about Japan's alternatives
to nuclear energy?

Arthur Berman: We have learned that it takes a lot of coal to replace
nuclear energy when countries like Japan and Germany made bold decisions to
close nuclear capacity. We also learned that energy got very expensive in a
hurry. I say that we learned. I mean that the past year confirmed what many
of us anticipated.

OP: Back in the US, we have closely followed the blowback from the
Environmental Protection Agency's (EPA) proposed new carbon emissions standards
for power plants, which would make it impossible for new coal-fired plants
to be built without the implementation of carbon capture and sequestration
technology, or "clean-coal" tech. Is this a feasible strategy in your opinion?

Arthur Berman: I'm not an expert on clean coal technology either but
I am confident that almost anything is possible if cost doesn't matter. This
is as true about carbon capture from coal as it is about shale gas production.
Energy is an incredibly complex topic and decisions are being made by bureaucrats
and politicians with little background in energy or the energy business. I
don't see any possibility of a good outcome under these circumstances.

OP: Is CCS far enough along to serve as a sound basis for a national
climate change policy?

Arthur Berman: Climate-change activism is a train that has left the
station. If you've missed it, too bad. If you're on board, good luck.

The good news is that the US does not have an energy policy and is equally
unlikely to get a climate change policy for all of the same reasons. I fear
putting climate change policy in the hands of bureaucrats and politicians more
than I fear climate change (which I fear).

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